Arizona Inheritance & Estate Tax: How to ‘Legally’ Avoid

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Paul Sundin, CPA

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Arizona residents who have a sufficient estate within the state or other states or inherit a property should be aware of the local and federal inheritance tax structures.

While Arizona itself levies neither inheritance nor estate taxes, there are certain cases when heirs are still responsible for paying a tax due.

In this article, we shall talk about the federal estate taxes and their exemptions and how estate planning can help Arizona residents reduce the taxable part of their estate, protecting their hers` welfare.

The inheritance and estate taxes for Arizona residents

The federal estate tax applies to all estate that exceeds the exemption level of $12,06 million. 

This number changes annually. It is attached to the current inflation level and is relevant for the estate of people who died in the given year. In other words, if a person died in 2021, their estate`s taxable part is calculated from the limit of $11,7 million, while in 2022, it is already $12,06 million.

Even if the estate exceeds the exemption limit by $1, it becomes a subject for the federal estate tax with a progressive rate of up to 40%.

Also, Iowa, Kentucky, Nebraska, New Jersey, Pennsylvania, and Maryland are the states that levy an inheritance law. Moreover, Maryland has both inheritance and estate laws. If you have or inherit property in those states, it is still subject to local inheritance and estate taxes, even for Arizona residents.

Professional assistance in estate planning and inheritance procedures will help you remain aware of all the peculiarities of the local and federal tax laws and reduce the taxable part of your estate.

Federal estate tax rules

In the wake of the Affordable Care Act, many Americans are beginning to worry about the Federal estate tax. The estate tax is a huge burden on the nation’s finances, and it is currently the most significant tax that Americans will ever face.

It is important to remember that the federal estate taxes are not based on the original purchase price of your assets. Instead, the estate will be taxed on the current market value. This is a good thing, as you don’t want to be taxed on your assets at their peak value.

The exemption amounts for the Federal estate tax are quite generous. Currently, the exemption amount is $11.7 million, but that number is increasing every year. If you’re married, you can transfer the rest of your estate to your spouse and shelter the remaining $1.7 million.

This is great news for you and your family. As long as you know about the exemption limits, you can minimize the amount of tax that you owe. And if you are married, you can pass the remainder of your estate to your spouse to avoid the tax entirely.

The federal estate tax was first enacted by the U.S. Congress in 1916. The modern U.S. estate tax is based on the value of the estate at the time of death. But there are certain loopholes that allow a wealthy family to reduce their taxes.

It is important to keep in mind that the threshold is higher than the threshold amount, so you should make sure you have enough funds to pay the full amount.

Lifetime gifts and inheritance

Arizona also does not have a gift tax. It allows the state`s residents who have a sufficient estate to reduce its taxable part legally without any adverse fiscal side effects.

The federal gift tax has an exclusion of $16,000 per done per year. Suppose you have 2 children and 3grandchildren. It allows you to gift away at least $80,000 worth of your estate, protecting it from federal taxation. Those numbers double for married couples.

Moreover, the following gifts that also decrease your taxable estate are not subject to the federal gift tax even if they exceed the $16,000 exclusion limit:

  • Gifts between 2 spouses who are both US citizens;
  • Payments for medical treatments and academic studies as long as they are transferred directly to the institution or service provider;
  • Donation to IRS-approved funds.

Lifetime gifting is an essential part of estate planning in Arizona that will help you take control over your estate`s tax bill and allow you to protect your heirs` welfare. 

The first step in avoiding Arizona estate taxes is to determine if your assets are taxable. Assets held in Arizona names must be probated, even if they are community property, tenants in common, or retirement plans.

If your spouse has passed away, the remaining assets go to your children or spouse in equal share, regardless of whether the marriage is dissolved or remained intact. If you die without leaving a will, your heirs will inherit the entirety of your estate and the remainder of any community property and separate property.

If the deceased had assets that produced income during their lifetime, an estate in Arizona could incur an income tax liability. This liability is usually small and can take six to twelve months to settle.

Benefits of setting up a trust

Depending on the type of trust, tax rules on trust income vary. Some trusts are disregarded entities and not taxable, while others are treated as separate taxable entities. Most taxpayers treat them as Grantor Trusts, meaning they pay taxes on the trust’s income only if they exceed the standard deduction or personal exemption. A beneficiary of a trust may not owe any taxes on the trust’s income until the beneficiary begins to use the trust funds.

The trust tax rules affect the amount of money a beneficiary can receive. If the trustee is not an individual who pays income taxes, the beneficiary may be entitled to a lower federal tax rate than the trust tax rate. This means that a trustee would lose a substantial income tax deduction every year. A charitable trust must provide a higher income tax benefit than a traditional IRA. If the trustee is an individual who earns a good living and pays no taxes, a charitable trust can be a good option.

However, if the trust is a joint-ownership, the trust may have a co-trustee who makes distributions to beneficiaries. If the trust is managed by two people, the trust is taxed jointly. The trustee and the beneficiary must file separate tax returns. If the beneficiaries are not joint-owners, then the income is taxable to them. The IRS considers this situation as a gift and the recipient is responsible for paying the taxes.

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Final Thoughts

If you had no intention of passing your assets to your heirs, the Arizona estate tax could be due as well. A surviving spouse may have to file a claim for a higher tax bill in order to avoid paying the inheritance tax. However, you will not owe any Arizona estate tax if your spouse died intestate.

If your deceased spouse passed away, the state has passed an Arizona estate tax exemption that protects out-of-state heirs. The statute does not require an attorney to file a claim.

In the event of an intestate death, you must contact the Arizona Department of Revenue in order to file. It will help you determine your eligibility for a tax exemption. This tax exemption will be higher for the next generation than for the deceased’s estate.

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Estate CPA

Gilbert, AZ